In early August 2009, PepsiCo (PEP) announced plans to acquire its two biggest bottlers (Pepsi Bottling Group and PepsiAmericas) in deals worth roughly $7.8 billion in aggregate. The reason, as noted by CEO Indra Nooyi, was too strengthen the competitive position in a key market: “We believe we are taking a very important step to strategically reshape the North American beverage business.” Muhtar Kent, CEO of Coca-Cola (KO), must have been intrigued by the announcement; six months later, Coca-Cola announced their own bottler acquisition, purchasing the North American bottling business of Coca-Cola Enterprises (CCE), their biggest bottler at the time; as part of the deal, Coca-Cola assumed $8.9 billion of CCE debt, and sold the company owned bottling operations in Norway and Sweden to CCE for $822 million (plus a working capital adjustment of $49 million). On top of that, CCE was given the right to acquire an 83% stake held by Coke in its German bottling unit for fair value between 18 and 39 months after the date of the agreement.

Ever since the blockbuster deals were announced, the focus has been squarely on KO and PEP, and how their recent acquisitions will transform their domestic operations. On the other hand, CCE has faded out of the discussion. This article will look at the opportunities and the outlook in 2011 for Coca-Cola Enterprises, the company that is the driving force behind much of Coca-Cola’s success in Europe.

As outlined in an article by Jeremiah McWilliams of the Atlanta-Journal Constitution, the deal has cut revenues by roughly two-thirds (down to $7-8 billion annually), which will move CCE to the third largest Coca-Cola bottler in the world. Despite this (relatively meaningless) setback in status, the transition comes with some positives for the business as well. CCE was able to lighten the debt load on the balance sheet, which reached $8.7 billion last year; as of the third quarter filing, total debt has been reduced to a manageable $2.39 billion (compared to $3.1 billion in current assets). The other opportunity, which I believe is the main driver for a potential investment in CCE looking forward, is the noticeable difference between the North American and European market place, and how Coca-Cola’s strategy feeds into CCE’s strengths.

When discussing a potential investment in Coca-Cola, the conversation usually turns to growth via emerging markets; a look at the per capita consumption of Coca-Cola beverage products for countries like China (32 in 2009) and India (9) tell the story. However, Europe is usually bundled into the North American “saturated market” picture. Despite the widespread perception, this is not quite accurate. The average European drinks 180 Coca-Cola products per year (for comparison, this is less than Peru, Brazil, or South Africa); the average American, on the other hand, drinks 400 Coca-Cola products every year (Mexico tops out at 665 per capita). While this is far from India’s consumption levels, it still suggests that there is opportunity for growth.

Part of the reason has to do consumption habits in the region. In Western Europe, for example, carbonated soft drinks only have a 10% “share of stomach”, compared to 25% in the United States (according to Beverage Digest). For followers of the beverage industry, one thing immediately jumps out at you about this “problem”: the future is not in CSD’s. As has consistently been reiterated (and for periods of time incorporated into the stock price for both KO and PEP) by analysts, management, and mostly important the numbers, the trend is towards sports drinks, energy drinks, juices, and RTD teas & coffees. From Minute Maid to Powerade, and from Odawalla to Vitaminwater, Coca-Cola has, and will continue to, strengthen the brand portfolio through innovation, marketing, and acquisitions in order to maintain their position as the premier source for non-alcoholic beverages. On top of that, CCE operates from a position of strength due to economies of scale and presence, with dominant market share in Great Britain (51% share of soft drink sales as of Nov 2011), France (65%, and per capita consumption of only 137), Belgium (63%), The Netherlands (48%), Norway (55%), and Sweden (53%). In essence, the future development in the European market will directly benefit CCE, and turn this problem into an interesting opportunity.

On a recent call to discuss the outlook for CCE, CEO John Brock outlined fourth quarter 2010 expectations, as well as a diluted EPS estimate of $1.74-$1.78 for FY 2010. For 2011, the forecast calls for EPS growth of 10-12%; this works out to FY2011 EPS in a range of $1.94-$1.99, suggesting a median P/E of 12.85x estimated earnings. While this looks relatively cheap, it doesn’t grab my interest like MSFT, WMT, and JNJ do at similar valuations (12.3x, 13.9x, and 13.3x, respectively). The capital intensive nature of CCE’s business (which has required investments of nearly $1 billion annually in capital expenditures over the past four years) along with volatile business results dependent on an outside company (even if it’s KO) makes me feel uneasy compared with the relative safety of other investments. Regardless, interested investors should take the time to research CCE for a potential investment in a key piece to one of the strongest markets for a premier competitor in the beverage industry.

About the author:

Alex Morris

I am a recent graduate from the University of Florida; I received a finance degree as well as a real estate minor during my time at UF. I will be sitting for Level 1 of the CFA Exam in December 2011, as well as for my series 65 exam. I am a value investor, plain and simple.

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